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i would be happy for that Lloyds Banking Group (LSE:LOY) share price to get back to the price I paid when I first bought something.
I mean, it’s had a poor performance for several years now. And recovery from the 2022 crash is underway.
But this should surely give people buying today a better chance of growing their money fivefold, right?
what needs to change
For some stocks, it may be difficult to work out any kind of valuation. This is especially true for growth stocks, especially if they have not yet reached profitability.
Analysts use a variety of measures related to sales, asset values, and all kinds of things. But until we see sustained gains, all of that could be thrown by the wayside.
But, with Lloyds we don’t have that problem. Banks make profits, and we have measures related to earnings.
And this brings me to the first thing that will need to change. I’m talking about evaluation. And valuing bank stocks is no longer easy.
Forecasts put Lloyds shares at a price-to-earnings (P/E) ratio of 5.8. I think this is too little in the long run FTSE 100 Average around 15.
But the bigger question is, what is a reasonable P/E valuation for a bank? In the past, banks had scored highly. But the financial crisis shattered any illusions of infallibility. It turned out that banks weren’t the safest things on the planet.
Conversely, the new rules mean that bank balance sheets now have to be kept much stronger. But the investment world has not yet come to terms with where a bank’s valuation should lie.
Maybe a little below footsie average? Maybe around 12? Such a revaluation could double the Lloyds share price.
Then we come to the dividend yield, and we’re looking at a forecast of 6% from Lloyds. This is above the index average of 3.9%. Lloyds’ share price would therefore need to rise by around 50% to bring its yield up to average.
Combined, the P/E and dividend yield suggest a revaluation could lift Lloyds shares by around 50%-100%.
I will be happy with that. But to get to five times the gains, we’ll need some serious earnings growth.
We don’t really have much growth potential right now. So I have to resort to speculation.
Let’s say Lloyds can grow its earnings by 5% per year, and the P/E remains at today’s low level of 5.8. My spreadsheet suggests it should take about 33 years for the Lloyds share price to quintuple at that rate.
However, there is no change in valuation.
If we expect the P/E to grow between 50% and 100%, this would suggest between five bags from 19 to 25 years.
This will be on top of the annual dividend stream that investors will also enjoy.
What does it mean?
Now, I’m not trying to predict anything here. I am simply trying to show what might be required for a fivefold increase in the Lloyds share price.
And, despite the obvious risks right now, it makes me consider bank stocks cheap.
What will it take for the Post Lloyds share price to climb 5X? appeared first on The Motley Fool UK.
Alan Oscroft holds positions in Lloyds Banking Group PLC. The Motley Fool UK recommends Lloyds Banking Group PLC. The views expressed on the companies mentioned in this article are those of the author and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a wide variety of insights can make us better investors.
Motley Fool UK 2023